Start over on RSPT, end miners’ uncertainty

With
Julia Gillard
as the new Prime Minister, the federal government should clear the decks with the resource super profits tax (RSPT) and start again.

Gillard has said: “To reach a consensus, we need to do more than consult – we need to negotiate."

This is a promising beginning, with both sides agreeing to end their advertising campaigns.

So what is there to negotiate? As a former partner of the litigation lawyers Slater and Gordon, Gillard is not a stranger to this process.

The mining industry and the government both agree that the existing system of mining companies paying royalties to state governments based on output or gross sales revenue is not working well. In some cases the companies pay too much and in other cases they pay too little.

The PRRT dates back to the early 1980s and has not discouraged offshore petroleum exploration and development.

This tax, like Kevin Rudd’s proposed RSPT, is at the rate of 40 per cent. But aligning a modified RSPT with the PRRT would mean dropping the proposal that a super profit be defined as a return above the long-term bond rate.

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Instead, the tax base would be a profit that exceeds a mining company’s typical cost of capital. This might be calculated differently depending on the type of project and expenditure.

The cost of capital for exploration is greater than for mine development, which in turn is greater than the cost of capital for continuing production.

Aligning the RSPT with the PRRT would also mean Gillard dropping the proposal that the government refund 40 per cent of the untransferable loss on the failure of a mining project.

This aspect of Rudd’s RSPT lacked credibility and posed a significant economic risk for the government, when – not if – the current resources boom ends.

The original Henry review model for the RSPT maximised revenue in the short term, but posed an unacceptable long-term risk.

It would still be necessary for Gillard to offer to refund companies for the royalties they pay to state governments. The RSPT was proposed to replace the existing state royalties regime, and a son-of-RSPT would have to do the same.

In some cases, there would be a net cost for the federal government, if the tax collected from a company was less than the royalty.

However royalties have declined in recent years as a share of mining company profits, and it is likely that in the large majority of cases, the net revenue for the federal government would be positive.

The most difficult part of the negotiations for Gillard, if she is to reach a consensus, is what is to be done with existing projects.

The Henry review proposed that the RSPT apply to existing projects and the starting base for calculating the profit was to be carried-forward capital expenditure.

Mining companies will correctly claim that their carried-forward capital expenditure does not usually reflect the underlying cost for their shareholders, who may have recently acquired their shares and underlying interest in the project at a price greatly exceeding its historic cost.

If Gillard wishes to include existing projects in her son-of-RSPT and reach a consensus she will have to agree to market value of the project as the starting base for calculating profit.

This would pose a significant revenue risk for the federal government. It is quite possible that the overall tax raised under a son-of-RSPT from existing projects, with market value as a starting base, would be less than state government royalties.

A likely outcome of a consensus approach is that in the run-up to the election, Gillard and the mining industry will agree on a son-of-RSPT resembling the PRRT. This would incorporate a refund to mining companies of state government royalties, and most importantly would exclude existing projects.

By so doing she would end the commercial uncertainty that now overhangs the mining industry and that has damaged Australia’s reputation internationally as a safe haven for investment. The sovereign risk argument would disappear overnight.

Of course, if Gillard excludes existing projects, the revenue from a son-of-RSPT that applies only to new projects is likely to be very modest for some years to come.

Some of the promises that were to be funded by the RSPT, such as cutting the company tax rate to 28 per cent, may no longer be affordable. But many of these promises were not big-ticket items anyway, and hopefully will not be jettisoned.

Gillard would make herself a small target electorally and get a new tax in play.

The speed and decisiveness she can display in stitching up a quick consensus will be important in forming the perceptions of the electorate and international investors.